Abstract
This paper studies how a firm can leverage by-product synergy for competitive
advantage. By-product synergy is defined as the conversion of a firm's waste
stream from a manufacturing process into valuable feedstock for another
manufacturing process. The distinguishing operational characteristic of a firm
practicing by-product synergy is that quantities of the primary product and
by-product are linked, with production of the primary product defining the upper
bound of the quantity of the by-product. We find that it is almost never
profit-maximizing for the firm to continue business-as-usual producing the
primary product and converting all its waste into by-product. In some cases,
when the markets for the primary and by-products are "separable", it is optimal
to convert only a portion of the waste into by-product and disposing of the
rest. In other cases, when the markets are "interdependent", the firm should
increase production of the primary product in order to capture more value in the
by-product market. In the latter case, all waste is converted into by-product.
Because the two markets are linked through the firm's (proportional) production
of primary and by-products, the optimal quantity of the primary product
increases in the demand elasticity of the by-product. As disposal cost
increases, the optimal quantity of the primary product (by-product) decreases
(increases) if the markets are separable, whereas if the markets are
interdependent, the optimal quantities of both primary and by-products weakly
increase. The first-order effect of increasing disposal cost is that the cost of
the primary (secondary) product increases (decreases). A second-order effect is
that, relative to its competitors, the firm practicing by-product synergy gains
a cost advantage. Therefore, as disposal cost increases, the total amount of
waste decreases more when there is a firm practicing by-product synergy than
when there is not.